Routing Rumble

The Federal Trade Commission once again is looking into debit card transaction routing, and the focus is mostly on online payments.

Here we go again: federal regulators are probing the seemingly arcane issue of how debit card transactions are routed. Anybody care for some caffeine? Abstruse as it may seem, this issue is anything but dry to those paying attention, and it affects every card-accepting merchant, not to mention card issuers and payment networks.

If merchants could only exercise in full their transaction-routing rights as spelled out in the Dodd-Frank Act’s Durbin Amendment they could save more than $600 million a year in card-acceptance costs, most of that in interchange, some merchant advocates say.

Of course, merchant savings translate into lost interchange revenue for card issuers, so the decades-old, built-in tension between the issuing and accepting sides of card payments is bubbling up to the surface yet again.

Enter the Federal Trade Commission. Late last year, Visa Inc. revealed in a Securities and Exchange Commission filing that the FTC, which has oversight authority over the card networks regarding competition issues, had asked it to voluntarily provide “documents and information for an investigation as to whether Visa’s actions inhibited merchant choice in the selection of debit payments networks in potential violation of the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act.”

Visa said in the filing that it was cooperating with the FTC, and a spokesperson says the company has no further comment.

Mastercard also acknowledged the FTC had requested information regarding Durbin-related routing requirements, and that it, too, was cooperating.

“But, to be clear there is no specific claim or complaint being made and, importantly, there has been no finding of any violation,” a Master­card spokesperson tells Digital Transactions by email. “This is an initial, preliminary investigation by the FTC. Once they have completed this exercise, we’ll understand their next steps and plans.”

The commission isn’t talking. “The FTC does not comment on or disclose the existence of investigations,” a spokesperson says in an email message. “If a company chooses to disclose an investigation, the FTC does not comment further.”

The Real Issue

While the FTC is mum, signs are appearing about which rocks it’s turning over. Merchants and the so-called PIN-debit networks—Star, Pulse, Shazam, etc.—contend the global networks—Visa and Mastercard—through their rules and technical requirements support issuers by making it difficult if not impossible to route card-not-present debit transactions, including online, card-on-file, and in-app payments, to the PIN networks.

Merchant groups and PIN-debit networks have brought their concerns to the Federal Reserve, which has regulatory authority over banks and implemented the Durbin Amendment through its Regulation II. It’s a fair guess that merchant and PIN-debit partisans have brought these same concerns directly to the FTC, or that the FTC has learned about them through the Federal Reserve.

On June 11, some 15 lawyers and executives representing several merchant trade groups, two PIN-debit networks, a processor, and retailers Walmart Inc. and Target Corp. met with eight Federal Reserve Board staff members “to discuss their observations pertaining to card-not-present routing of debit card transactions and tokenization in the market,” says a brief summary of the meeting by the Fed.

The group also brought to the Fed’s attention their concerns about the new Secure Remote Commerce specification for e-commerce purchases from EMVCo, the standards body owned by Visa, Mastercard, American Express Co., Discover Financial Services, China’s UnionPay, and Japan’s JCB. Merchant groups have long claimed EMVCo’s standards reinforce the global networks’ control of card payments, an assertion the networks deny.

That meeting came one day after five Mastercard representatives and an attorney spoke with Fed staff about the same topics.

The real issue behind the routing dispute is money—who pays or receives the most revenue from a debit transaction. PIN-debit networks generally charge merchants less in interchange, which is paid by the merchant to the issuer of the card the consumer used in a transaction, than do Visa and Mastercard for so-called signature-debit purchases.

‘Hundred Years’ War’

The PIN-signature debit conflict started in the late 1980s and early 1990s when Visa- and Mastercard-branded debit cards first appeared, years after issuers added point-of-sale functionality to their PIN-based ATM cards.

Merchants scored their biggest victory in 2010 when Congress passed Dodd-Frank with its pivotal debit card amendment sponsored U.S. Sen. Richard Durbin, D-Ill. Durbin’s amendment capped the interchange large issuers could receive from a debit transaction at about 22 cents, and, as implemented by the Fed’s Regulation II, required all issuers’ cards to give merchants access to at least two unaffiliated debit networks for routing.

Durbin’s idea behind the routing provision was to promote network competition and break up the common practice of issuers striking exclusive deals with the global networks.

For example, many issuers cranked out cards that routed signature-debit transactions over the Visa network and PIN-debit purchases only over the Visa-owned Interlink network. Ditto for exclusive deals involving Mastercard, which owns the Maestro PIN-debit network (“The Durbin Amendment Half a Decade Later,” July, 2017). Interlink’s volumes took a huge hit after the routing provisions kicked in.

The conflict flared again about six years ago with the coming of EMV chip cards, which in their original European iteration could not route transactions to the U.S. PIN-debit networks. Fixing that problem to comply with Durbin required the payments industry to develop the so-called common application identifier, or common AID, that in effect lifted the gate at the entrance ramp to the PIN-debit road.

“This is like the Hundred Years’ War,” says Jeff Tassey, chairman of the Electronic Payments Coalition, a Washington, D.C.-based advocacy group for networks and banking trade groups.

In recent years, the PIN-debit networks have broadened their product offerings from their original single-message debit (PIN-based authorization and settlement in one transaction) to dual-message (authorization and settlement in separate transactions, as in Visa/Mastercard signature-authorized debit), to PINless debit, and other services.

Now the spotlight is turning to fast-growing online and mobile payments, a market the global networks dominate. In a recent report, CMS Payment Intelligence Ltd., a Manchester, England-based merchant-oriented consulting firm with a U.S. office in Atlanta, cites Federal Reserve research saying card-not-present transactions now account for about 30% of all card spending.

But merchants can’t route many online debit purchases to the PIN-debit networks because of the global networks’ policies and technical requirements, according to CMSPI. If they could, the savings to merchants as of 2017 would have been “more than $600 million per annum,” says Callum Godwin, the firm’s chief economist.

“That number is going up real fast—obviously e-commerce is growing faster than other payment types,” he says. In fact, CMSPI pegs the potential savings at about $1 billion by the end of next year.

CMSPI compiled its estimates based on proprietary data it receives from its merchant clients, which include Marriott, Panera Bread, Shell, Red Lobster, and others.

Adds Owen Glist, a partner with Constantine Cannon LLP, a New York City-based antitrust law firm that advocates for merchants in major payments cases: “The pie of routable transactions is shrinking if e-commerce transactions are not available to be routed.” Glist attended the June 11 meeting with Fed staff.

Merchant advocates say their routing choices for POS transactions are largely respected. But with online, card-on-file, and in-app mobile payments, the global networks have policies and operational requirements that wall off the PIN-debit networks from this growing transaction market in violation of the Durbin Amendment, they say.

‘A Business Issue’

“The technologies being deployed are drivers behind the questions,” says Dan Kramer, executive vice president of government and community relations at Johnston, Iowa-based Shazam Inc., a debit network and payment processor.

A 21-page paper compiled by the National Retail Federation that the merchant groups left with Fed staff details their concerns. Much of the report is technical, but claims it makes include:

– Requirements that tokenized in-app and card-on-file transactions be routed only to the global networks. Tokenization is the system in which a 16-digit primary account number is replaced by digits useless to fraudsters, enhancing security. Merchants say Visa and Mastercard have refused to de-tokenize transactions processed by other networks, shutting out the alternative networks.

– Issuers not enabling bank identification numbers so that certain debit transactions can access PIN-debit networks. “The functionality is not being enabled on the card by the issuer,” says attorney Glist.

– Prioritizing the so-called global application identifier, which, depending on the brand on the face of the card, routes a debit transaction to either Visa or Mastercard, over the common AID that can access the alternative networks.

Other issues include policies that reward issuers and merchants for sending transactions to the global networks, or in Mastercard’s case, penalize issuers with fees for transactions originated on a Mastercard-branded card that went to the PIN networks.

And, back in the physical world, the global networks have policies that give them the upper hand in very fast contactless transaction environments—think New York subways, according to Paul Tomasofsky, executive director of the Debit Network Alliance industry group. Here, PINless transactions could be an option but global network policies allegedly thwart that.

“It has nothing to do with technology functionality, it’s a business issue,” Tomasofsky says.

Erecting high technical requirements especially hurts small merchants looking to make the most of their debit-routing options, according to researcher Sarah Grotta, director of the debit and alternative products advisory service at Mercator Advisory Group Inc., Marlborough, Mass.

“My understanding is that it can be done, you’ve got the really big guys, the Walmarts and the Targets, they’ve got the tech teams,” Grotta says. But for smaller retailers, “it’s simply not in their purview.”

Both the FTC and the Fed have refereed routing disputes before. In 2016, both agencies made inquiries into Visa’s rules and technical specifications that resulted in some POS terminals requiring consumers to make a choice of AID. The Fed ultimately issued guidance that any network rule giving consumer choice priority over merchant routing choice violated the Durbin Amendment.

Merchant Rights

The FTC ended its investigation when Visa made changes making clear that “merchants can continue to route debit transactions to any payment card network enabled on the card for that transaction and that merchants are not required to display these application selection screens to their customers,” a November 2016 FTC letter to Visa says.

It’s unknown how long the FTC’s current investigation will take and what it will conclude. But merchant advocates hope the result will be unequivocal guidance from regulators that Durbin applies to all forms of debit, card not present in addition to the point of sale.

Still, Tassey of the Electronic Payments Coalition hopes regulators won’t mess with the debit market too much. He notes that, after it took effect, the Durbin Amendment spurred many banks to scale back free checking because they lost so much debit revenue from the interchange cap. (The price cap initially cut big issuers’ interchange revenues by about 50%). Some issuers also ended debit card rewards programs.

“There’s just no way to have a government intervention like this on behalf of one party in the two-sided (issuer/merchant) market without having unintended consequences,” he says.

 

A Cross-Border Controversy

Disputes over debit card transaction routing are hardly confined to the United States. Routing has been a contested topic for years in Australia, and recently the country’s central bank signaled it might force banks to send more contactless debit transactions to the local EFTPOS network rather than automatically sending them over the Visa and Mastercard networks.

As in the United States, Australian card issuers earn more interchange revenue from Visa and Mastercard transactions than they do from alternative debit networks. But Australian financial regulators want to reduce payment costs in the economy, and they appear sympathetic to merchants’ arguments that retailers deserve more choice in how transactions are routed.

An Australian retail trade group estimates merchants pay A$300 million to A$500 million ($200 million to $340 million) in extra costs per year under current routing practices that favor the bank card networks, the Reuters news service reported in February.

The spotlight is turning to rapidly growing contactless payments, which Visa and Mastercard dominate. By 2016, contactless payments had already accounted for one-third of face-to-face card payments, according to research for the central bank, the Reserve Bank of Australia.

“We have made it very clear to the banking industry that we expect them to develop the functionality to allow the merchant to choose which payment rails it goes through, the international schemes or the EFTPOS schemes,” RBA Governor Philip Lowe told reporters after a recent speech, according to Reuters. “If that process doesn’t work then we would have to consider a regulatory solution.”

Last May, an RBA board responsible for payments policy issued a statement “that the benefits to competition from least-cost routing [of debit transactions] should not be prevented by issuers removing networks from dual-network cards.”